Environment and Theoretical

Structure of Financial Accounting

Chapter 1

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

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Financial Accounting Environment

Providers of
Financial External
Information User Groups
Investors
Creditors
Profit-oriented Relevant Employees
companies
Labor unions
Not-for-profit Customers
entities Financial Suppliers
Information Government
Households agencies
Financial
intermediaries
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Financial Accounting Environment

Relevant financial information is provided primarily through financial
statements and related disclosure notes. The following financial
statements are the most frequently provided.
1. Balance Sheet
2. Income Statement
3. Statement of Cash Flows
4. Statement of Shareholders’ Equity
Starting in 2012, companies must either provide a Statement of
Other Comprehensive Income immediately following the
Income Statement, or present a Combined Statement of
Comprehensive Income that includes the information normally
contained in both the Income Statement and the Statement of
Other Comprehensive Income.
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Cash versus Accrual Accounting

Cash Basis Accounting
Revenue is recognized when cash is received.
Expenses are recognized when cash is paid.
O
R
O
OR
R
O
R

Accrual Accounting
Revenue is recognized when earned.
Expenses are recognized when incurred.
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The Development of Financial

Accounting and Reporting Standards

Concepts,
principles, and
procedures
developed to meet the
needs of external
users (GAAP).
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Historical Perspective and Standards

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Current U. S. Standard Setting

Financial Accounting
Standards Board

 Supported by the Financial Accounting

Foundation
 Seven full-time, independent voting members
 Members not required to be CPAs
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International Standard Setting

The main objective of the International Accounting

Standards Board (IASB) is to develop a single set of
high quality, understandable, and enforceable
global accounting standards to help participants in
the world’s capital markets and other users make
economic decisions.
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Efforts to Converge U.S. and

International Standards
Issues and Concerns:
 Desire for a single set of global standards
 Need for standards that are customized to fit stringent legal and
regulatory requirements of U.S.
 Possible differences in implementation and enforcement

Progress:
 September 2002: FASB and IASB sign Norwalk Agreement.
 November 2008: SEC issues a Roadmap with milestones.
 May 2011: SEC issues discussion paper describing a
“condorsement” approach.
 November 2011: SEC issues two studies comparing U.S. GAAP
to IFRS and analyzing how IFRS are applied globally.
 December 2011: SEC postpones final determination until 2012.
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A Move Away from

Rules-Based Standards?
Rules-based accounting standards
vs.
Objectives-oriented approach

Objectives-oriented
(principles-based) approach
stresses professional
judgment
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The Conceptual Framework

The Conceptual Framework has been described as
an “Accounting Constitution.” It provides the
underlying foundation for accounting standards.

FASB Conceptual Framework

(Statements of Financial Accounting Concepts)
Objectives of Financial Reporting (SFAC 1, replaced by SFAC 8)
Qualitative Characteristics (SFAC 2, replaced by SFAC 8)
Elements of Financial Statements (SFAC 3, replaced by SFAC 6)
Recognition and Measurement (SFAC 5 and SFAC 7)
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The Conceptual Framework

Objective
To provide financial information
that is useful to capital providers.

Qualitative Recognition and

Characteristics Elements Measurement
Concepts

Financial
Constraints Statements
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Qualitative Characteristics of
Accounting Information
Decision usefulness

Relevance Faithful representation

Predictive Confirmatory Free from

Materiality Completeness Neutrality
value value error

Comparability
Verifiability Timeliness Understandability
(Consistency)
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Elements of Financial Statements

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Elements of Financial Statements

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Recognition, Measurement and

Disclosure Concepts
Criteria:
Recognition 1. Definition
Process of admitting information into 2. Measurability
the basic financial statements 3. Relevance
4. Reliability
Measurement Attributes:
1. Historical cost
Measurement 2. Net realizable value
Process of associating numerical 3. Current cost
amounts with the elements. 4. Present value of future
cash flows
5. Fair value

Examples:
Disclosure 1. Parenthetical amounts
Process of including additional 2. Notes to FS
supplemental information. 3. Supplemental FS
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Revenue Recognition: Realization

Two Criteria:
1.Earnings process is complete or virtually complete.
2.Reasonable certainty as to the collectability of the
asset to be received (usually cash).
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Expense Recognition: Matching

The matching principle requires that all
expenses incurred in generating revenue for a
period also be recognized in the same period.

Four Approaches
1.Based on exact cause-and-effect relationships.
2.By associating an expense with the revenues recognized
in a specific time period.
3.By a systematic and rational allocation to specific time
periods.
4.In the period incurred, without regard to related revenues.
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End of Chapter 1